Lose-lose for equities?
Market trends this quarter resemble 2017: equities rising, suggesting good times ahead, and bond yields falling, predicting the opposite. Even if the messages are more muted today, they can’t both be right. Two years ago we commented that bonds have the better predictive record and that eventually equities would fall in line. We would not claim to have been precisely right, as equity markets have recovered much of the ground lost at the end of 2018. However, it’s certainly true that economic growth is flagging and investor risk appetite has fallen, according to data from our friends at CrossBorder Capital.
This time round the liquidity background is less bleak since the Federal Reserve changed tack in January, though the data shows most central banks are continuing tight monetary policy. Despite this, low bond yields remain a key predictor of lower economic growth. Our view is that high valuations continue to make equities vulnerable both to disappointing earnings growth and to a more general market setback. We would back the message from bonds.
Some will say that high valuations (and they are high – probably only topped in 1929, the dotcom bubble and 2018) are justified by lower bond yields. Our view is that it’s a lose-lose situation for equity markets. If we’re wrong about the fundamental background, bond yields will rise, putting pressure on equity valuations. If we’re right, earnings will disappoint, with the same result.
Find out more here.